Which of the following ratios would be the best way to determine how customers are paying for their purchases?
a) Total asset turnover
b) Inventory turnover
c) Average collection period
d) Current ratio
I believe it would be the Average collection period because it shows credit purchases.
It measures the average number of days it takes for a company to collect payments from its customers.
You are correct, the average collection period would be the best ratio out of the options provided to determine how customers are paying for their purchases. The average collection period measures the average number of days it takes for a company to collect its accounts receivable. This ratio provides insight into the credit sales and the ability of customers to pay their debts promptly.
To calculate the average collection period, you need two pieces of information: accounts receivable and credit sales. Here's how you can calculate it:
1. Determine the accounts receivable balance, which represents the amount of money owed to the company by customers who have made purchases on credit.
2. Determine the credit sales, which represents the total amount of sales made on credit during a specific period.
3. Divide the accounts receivable by the average daily credit sales.
The formula for calculating the average collection period is:
Average Collection Period = (Accounts Receivable / Credit Sales) * Number of days
By analyzing the average collection period, you can assess the efficiency of your company's accounts receivable management, evaluate the creditworthiness of customers, and monitor the cash flow cycle.